Pre- Versus Post-Crisis Central Banking in Qatar
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Munich Personal RePEc Archive Pre- versus Post-Crisis Central Banking in Qatar Elsamadisy, Elsayed Mousa and Alkhater, Khalid Rashid and Basher, Syed Abul Dept. of Research Monetary Policy, Qatar Central Bank 21 March 2013 Online at https://mpra.ub.uni-muenchen.de/45310/ MPRA Paper No. 45310, posted 21 Mar 2013 10:59 UTC Pre- versus Post-Crisis Central Banking in Qatar∗ Elsayed Mousa Elsamadisy† Khalid Rashid Alkhater‡,§ Syed Abul Basher¶ March 21, 2013 Abstract In the years before the global financial crisis of 2008–2010, Qatar experienced a huge build- up of liquidity surplus in the banking system, mainly driven by surging net capital inflows. This paper identifies various sources of interbank liquidity in Qatar and discusses the various implications of structural primary liquidity surplus for the money market in particular and the economy at large. The paper attempts to evaluate the Qatar Central Bank policy mak- ing and conduct during the pre- and post-crisis periods within a framework of the Austrian monetary overinvestment theories, and concludes that the central bank had forcibly commit- ted several forced monetary policy mistakes, which resulted in a breakdown in the interest rate channel of the monetary policy transmission mechanism. This led to the inability of the central bank to control the interbank interest rate and to an accelerating inflation rate during the pre-crisis years. In contrast, a dramatic change in the central bank’s monetary policy framework and a deliberate monetary policy mistake on behalf of the central bank resulted in a restoration of the interest rate channel of the monetary policy transmission mechanism, stabilization of the interbank interest rate close to the central bank’s policy rate and a sharp deceleration in the inflation rate in the post-crisis period. The paper concludes by offering brief policy recommendations. JEL Codes: E51, E52, E58. Keywords: Monetary policy framework; Monetary policy mistakes; Liquidity management; Structural liquidity surplus; Financial crisis. ∗We are grateful to four anonymous referees for their constructive suggestions. We thank Cherin Hamadi for excellent research assistance and Megan Foster for help with proofreading. The views expressed here are those of the authors and do not reflect the official view of the Qatar Central Bank. †Chief Economist, Department of Research and Monetary Policy, Qatar Central Bank, P.O. Box 1234, Doha, Qatar. E-mail: [email protected] ‡Director, Department of Research and Monetary Policy, Qatar Central Bank, P.O. Box 1234, Doha, Qatar. E-mail: [email protected] §Scholar-in-Residence at Georgetown University, School of Foreign Service in Qatar, PO Box 23689, Doha, Qatar. Email: [email protected] ¶Economist, Department of Research and Monetary Policy, Qatar Central Bank, P.O. Box 1234, Doha, Qatar. Corresponding author’s Tel.: +(974) 44456490. Fax: +(974) 44416771. E-mail: [email protected] 1 Introduction The Gulf Cooperation Council (GCC)1 countries have emerged as one of the most financially liquid regions in the world on account of the unprecedented economic boom triggered by high oil prices during the last decade. The current account balance of the GCCs went up from US$32 billion in 2001 to US$256 billion in 2008, compared to the members of the Organization of Petroleum Exporting Countries (OPEC),2 whose current account rose from US$19 billion to US$184 billion over the same period. Figure 1, adapted from Peeters (2011), illustrates the composition of gross flows of the GCC’s current and capital account over this period. As Figure 1 shows, total portfolio investment outflows outstripped total portfolio inflows, reflecting the accumulation of hydrocarbon revenues by the GCC countries. Since 2003, government current spending has risen cumulatively by 58%, mainly reflecting rising wages and subsidies (International Monetary Fund (IMF), 2008). A policy mix of an expansionary fiscal stance and an easy monetary stance (imported via fixed exchange rates) resulted in growing economic deficits to be monetized by the central banks. The incidence of a liquidity surplus, in its broader sense, has been a common phenomenon observed across the GCC region during oil-price booms. The GCC’s high surplus led to strong domestic aggregate demand. Over a span of six years, the average annual growth in private consumption jumped from 8% in 2003 to over 24% in 2008, with Saudi Arabia exhibiting a nearly five-fold increase, and Oman and Qatar both presenting a four-fold increase. Gross capital formation increased from about 35% of the non-oil GDP in 2003 to about 48% in 2007 (IMF, 2008). Investments were broad-based in all countries except the UAE, where they were more concentrated in construction (Khamis et al., 2010). Robust aggregate demand (including exports) led to strong economic growth: over the 2003–2008 period, GCC countries grew at an annual average real rate of 7%. This impressive economic performance has been accompanied by a general increase in consumer prices. Average headline inflation jumped from 1.5% in 2003 to 10.6% in 2008, with considerable variation in the level and volatility of in inflation rates across the six countries.3 Being no exception within the GCC, Qatar has witnessed a gradual accumulation of net 1The GCC countries include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE). 2These include Algeria, Angola, Ecuador, Iran, Iraq, Libya, Nigeria and Venezuela. Among the GCC countries, Kuwait, Qatar, Saudi Arabia and the UAE are OPEC members. The authors’ calculations are based on the World Economic Outlook Database, April 2011, International Monetary Fund. 3All numbers, unless otherwise stated, are authors’ own calculations based on national sources. 2 capital inflows since mid-2000 owing to hydrocarbon revenues, geo-political and geo-economic developments. In particular, accumulation of foreign reserves on the asset side of the Qatar Cen- tral Bank’s (QCB’s) balance sheet can be traced back to the fraction of hydrocarbon revenues injected into the domestic economy via (i) the government budget; (ii) net private sector’s foreign borrowing; (iii) foreign direct investment (encompassing the cash portion of hydrocarbon-related investment and real estate purchase); and (iv) net short-term foreign portfolio investments (in- cluding stocks, bonds, bank deposits, etc.). Moreover, Qatar witnessed a further remarkable surge in foreign currency inflows beginning in late 2007, due to a speculative revaluation attack on the Qatari Riyal (QR). Such net inflows resulted in surges in the economic deficit4 that the QCB had to monetize. This, in turn, resulted in the accumulation of abundant QR liquidity on the liabilities side of the central bank’s balance sheet. This was not sterilized because, un- like some GCC central banks, QCB lacked a number of standard liquidity management tools that are commonly used to drain liquidity off the interbank market. Without effective liquidity management instruments, the imported Federal Reserve (hereafter Fed) easy monetary policy stance became over effective during the pre-crisis period. This was a serious concern for QCB as the interest rate channel of the monetary transmission mechanism was weakened, and because the potential pass-through of the interbank liquidity surplus to the general consumer price level. Going beyond acknowledging the threat of rising inflation and the subsequent appreciation of the QR real exchange rate, an accumulation of liquidity surplus in the interbank money market posed serious threats to the stability of the financial system, including risks posed by credit and asset prices booms, and sectoral entities’ balance sheet vulnerabilities. From a policy perspective, identifying the various channels of liquidity surplus is vital. The present paper endeavors to evaluate the QCB’s experience in managing liquidity in the interbank market under conditions of a structural primary liquidity surplus (PLS) and to provide relevant policy recommendations. Although this paper deals with the experience of Qatar, our analysis may be appropriate for other GCC economies. The rest of the paper is organized as follows: Section 2 introduces the concepts of primary liquidity and structural PLS, and discusses several sources of primary liquidity in the context of the Qatari economy. Section 3 presents important corollaries of the structural liquidity surplus in Qatar. Section 4 focuses 4By economic deficit, we mean the proportion of government expenditure financed by hydrocarbon revenues minus the net private sector’s transactions compared to the rest of the world. 3 on QCB’s primary liquidity management within the pre-crisis QCB monetary policy framework. In Section 5, we discuss significant post-crisis changes in the QCB monetary policy framework, QCB’s monetary policy conduct and the conduct of its liquidity policy. Section 6 attempts to evaluate QCB’s pre- and post-crisis experiences. Section 7 concludes the paper and presents some policy recommendations. 2 Primary Liquidity Surplus5 The phrase “liquidity” is used in practical central banking in the context of a wide range of measures of the quantity of money (encompassing the whole spectrum of monetary aggregates). Yet, in this paper, we focus on the narrowest liquidity concept most relevant for day-to-day central banking commonly known as “interbank liquidity”, “money market liquidity”, “QR liquidity”, or “primary liquidity.” Primary liquidity encompasses the entirety of free reserves held — voluntarily and involuntarily — by the depository institutions in their current deposit (settlement) accounts at the central bank. Voluntarily held free reserves are “excess reserves”, conventionally defined as the precautionary demand for banks’ reserves,6 while involuntarily held free reserves in excess of precautionary balances are a primary liquidity surplus. Where and when the cash flows into the money market exceed the cash flows drained into the central bank, the phenomenon of PLS occurs. If such a phenomenon persists for extended period, we have the phenomenon of “structural” PLS. The same process works in reverse for a structural primary liquidity shortage.